Office Market Martin Luthers

There’s a prevailing narrative in New York real estate, and it goes something like this: Lehman Brothers’ collapse sent the Manhattan office market into a horrifying and precipitous tailspin. Commercial tenants, fearing for their survival, fled in droves. Months of deathly inactivity followed. Then the fright passed. And the waiting game ensued. Tenants, their brush with the unknown having scared them from profligacy into prudence, waited patiently for the market to bottom. That happened this summer. And then they came back. Deal flow resumed. New tenants entered the market.

And the market commenced its recovery.

There are numbers that seem to support this narrative. CB Richard Ellis, New York’s largest commercial real estate brokerage, reported that September was midtown’s fourth straight month of more than 1 million square feet of office leases. And a number of them were new, big leases. Not only that, but the upper-upper tier of the market—which, as at the Seagram Building and Lever House, is traditionally tenanted by the so-called price-insensitive—has seen a recent spate of leasing. Yet more evidence of an sustainable market recovery, and maybe even an imminent rise in rents.

Or not.

You see, a phalanx of industry professionals, most of them tenant representatives, are offering a compelling counter-narrative. It’s nowhere near as rosy. It goes something like this: All of this new activity the market is witnessing is merely pent-up demand from the comatose months prior. Once it peters out, it’s in no way clear what, if anything, will replace it.

“All of the institutional forces are aligned against the truth,” said Ira Schuman, executive vice president at Studley, a tenant brokerage. “The owners want to interpret the current activity as a rise in rents, because, naturally, rising rents are good for owners. The brokers, many of whom are the owners’ handmaidens, want to say the market is rising because that’s good for the leasing agents and the owners they represent. The banks, who have the big loans on a lot of these buildings, many of which are under water, want to see the future as better than it is today, so they will have reason not to write off bad loans. And the government regulators also want the perception to be positive, because they don’t want to have to take over the banks that are going to go under.”

“There was an absolute pause in the first half of this year,” Mr. Weiss said. “People put off doing anything, even with critical action dates approaching. Toward the end of the summer, as prices adjusted, there was a surge of activity, most of which was from pent-up demand. And there was the irrational expectation that behind it would follow more and more transactions. That just hasn’t happened, because volume is still way off.”

Not only is much of the current activity merely pent-up demand, rather than new demand, said Robert Stella, an executive vice president and a principal at tenant brokerage CresaPartners, but when tenants have returned to the market, they are often doing so with scaled-back space requirements.

“Of the transactions that we are doing, I would say 30 or 40 percent are ending up as smaller leases than they were originally planned to be,” Mr. Stella said. “I have one transaction that began as 10,000 square feet in March of this year. It then went to 8,000 square feet. And then to 6,000. Now it looks to be about 5,500.”

Along the same lines, in many of the much heralded new leases that have been signed, tenants traded larger spaces for smaller ones, creating a net loss for New York City landlords.

Law firm Holland & Knight, when it moved from downtown to midtown’s 31 West 52nd Street, relocated from a 105,000-square-foot office to an 83,000-square-foot one, according to two industry sources. And German Bank West LB, in its much lauded relocation to 7 World Trade Center, exchanged 165,000 square feet for 129,000 square feet. And just think of all the shadow space that has yet to officially be included in the vacancy rate statistics—like the 1 million–square–foot 11 Times Square, or the hundreds of thousands of feet downtown that Goldman Sachs will vacate for its new headquarters.

WHAT DOES ALL THIS MEAN? The counter-narrative would say that until the job market recovers, and serious hiring begins in the financial, legal and media industries—the trifecta supporting the New York real estate market—the office market will stagnate.

“You still have a period of time that will pass before we have created a sufficient number of jobs to motivate demand for space,” said Sam Chandan, president and chief economist at Real Estate Econometrics. “As a benchmark, the last recession ended in November 2001. The vacancy rate in the office sector didn’t peak till late 2003, two years later, and it took a number of years after occupancy rates had stabilized for occupancy rates to rise enough that it finally motivated meaningful increases in rents and net operating income. It’s not a short lag.”

And as the market stagnates, tenants will have every reason to dither.

“We sit in our meetings and talk about all this deal flow that’s in the pipelines,” said Dale Schlather, executive vice president at Cushman & Wakefield. “People are getting hired for new things every day, and yet at the same time, you’re not hearing about a lot of closed deals.”

“My feeling is, it’s just kind of a general fear out there in the market,” Mr. Schlather said. “I don’t think it’s a real-estate–driven issue. I think it’s more of an economy-driven issue. It’s a fear that seems to have crept into the general conversation.”